Proposed Cap on IRAs Would Touch Middle Class

“Max out your retirement plans every year” has long been standard advice I’ve given to working adults who want to secure a reliable income when they retire. Individual Retirement Accounts (IRAs), along with 401(k), 403(b), and profit sharing plans offered by some employers, are among the most accessible ways for middle-class workers to provide for retirement and build wealth.

If a proposal in President Obama’s budget plan is approved by Congress, however, retirement plans may no longer be the first and best stop along the road to financial independence.

The proposal would limit a person’s total balance in all tax-advantaged retirement plans to the amount it would cost to purchase an immediate annuity paying $205,000 a year This appears to not be indexed for inflation. The articles I’ve read and my own calculations suggest this would mean capping retirement accounts at around $3 million.

From the sketchy details available so far, the proposal appears to target traditional IRAs and other tax-deferred retirement plans. Contributions to these accounts are made with pre-tax dollars, and the earnings in the account are not taxed until they are withdrawn.

Since 58% of Americans don’t have any retirement plan, my guess is they will pay little attention to this proposal. Saving $3 million dollars seems well out of reach. While that may be true in today’s dollars, it most likely will not be true in future dollars.

If inflation over the next 40 years matches that of the past 40, a $3,000,000 IRA in 2053 will be equal to $575,000 today. If today’s 25-year-old, retiring then, wanted to be sure the money would last another 40 years, the IRA would provide an income equivalent to about $1,500 a month.

Even in today’s dollars, the $3 million maximum isn’t as unreachable as it may seem. Employees can currently contribute a maximum of $5,500 per year ($6,500 for those 50 and older) to Roth or traditional IRAs. Small business owners and the self-employed may have SIMPLE (savings incentive match plan for employees) or SEP (simplified employee pension) IRAs. The maximum annual contribution is currently $17,000 for a SIMPLE and $51,000 for a SEP. A self-employed plumber, business owner, or doctor who was a conscientious saver with a diversified portfolio could certainly accumulate $3 million over a lifetime.

Or suppose the wife of a small business owner was a self-employed counselor with her own SEP plan. If he died at age 58 and she inherited his IRA, the combined totals could easily put her over the $3 million cap.

It isn’t clear how the proposal would equate the withdrawal rate with the cap. One possibility would be to raise the required minimum distribution amount, which would erode the value of an IRA more quickly. Another option would be to penalize excess accumulations with a hefty tax of 40% or more. Of course, the President could follow in Argentina’s footsteps and just confiscate any amount over the cap. Any of these would add to the diminution of retirement plans as a vehicle for income during retirement.

The proposal includes this statement: “But under current rules, some wealthy individuals are able to accumulate many millions of dollars in these accounts, substantially more than is needed to fund reasonable levels of retirement saving.”

Apparently we, as individual citizens, are not considered capable of defining “reasonable levels” of retirement saving for ourselves. The real goal of this plan appears to be wealth distribution, instead of encouraging more Americans to save and provide for their own retirement.

You can read more about this proposal at Bloomberg and Market Watch, and here is a link to the President’s budget. If this proposal is passed, retirement plans will play a much smaller role in many middle class Americans’ golden years.